How are NCDs taxed?

I bought a NCD of face value Rs 5,000 from the secondary market for Rs 5,200. Annual interest was Rs 500. I bought it when it was about to mature in four months. On maturity, I got Rs 5,500. So my gain is Rs 300. How will this be taxed? 1) Capital gain of Rs 300 2) Interest income of Rs 300 3) Interest income of Rs 500 and capital loss of Rs 200 - Vineet Mittal

To understand how NCDs are taxed, we need to know the types of income that can come from them.

But what are NCDs?

For those who are unfamiliar, NCDs (non-convertible debentures) are a type of long-term debt instrument that companies issue to raise funds. These offer a fixed interest rate and have a fixed maturity date. They cannot be converted into equity shares.

Income from NCDs
Now, there are two types of income that can come from NCDs: interest income and capital gains. Interest income is the fixed interest payout that NCDs offer. This income is added to your taxable income and taxed according to the applicable tax slab.

Capital gains, on the other hand, depend on how long you hold the NCDs. If you sell them within 12 months, the gains are considered short-term capital gains (added to the investor's total income) and taxed at the applicable income tax rate. If you sell them after 12 months, the gains are considered long-term capital gains and taxed at a lower rate of 10 per cent without indexation.

The case at hand
Based on the information provided by you, it appears that you received Rs 5,000 as face value of NCD on redemption and an additional Rs 500 as annual interest.

And as described above, the interest income of Rs 500 will be added to your taxable income and taxed according to the applicable slab. With regards to capital gains, it appears that you have incurred a short-term capital loss of Rs 200, as you purchased the NCD for Rs 5,200 and redeemed it for Rs 5,000 after a holding period of four months.

This short-term capital loss can be offset against any other short-term or long-term capital gains you may have. Any remaining unutilised loss can be carried forward for eight consecutive years.

Suggested read: Taxation of long-term capital assets